Your Money, Their Pockets

Seldom in our 230-odd years as a country have Congress and the White House had the fortitude to impose on American bankers and financiers a set of regulations sufficiently stringent to prevent them from pushing us into destructive panics and recessions. And once again Washington may be demonstrating its lack of backbone.

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As Simon Johnson and James Kwak recount in “13 Bankers: The Wall Street Takeover and the Next Financial Meltdown,” the struggle to keep bankers in check goes back to Thomas Jefferson and Andrew Jackson, with results that have usually been mixed. Given the leeway to undermine the economy, bankers and financiers have done just that.

To put it bluntly, as this book does: the efficient-market hypothesis does not work. It never has. Markets are not self-­correcting. Left to their own devices, bankers at the biggest institutions can’t seem to stop themselves from speculating with borrowed money until they inevitably crash the system.

Johnson, a professor of entrepreneurship at M.I.T.’s Sloan School of Management, and Kwak, a former consultant for ­McKinsey & Company, tell this story in matter-of-fact prose. Even their discussion of derivatives is accessible to ordinary readers (most of the time). Their conclusion: during only one period over the past two centuries was government regulation sufficiently restrictive to rein in Wall Street and the bankers. “The result,” they say, “was the safest banking system that America has known in its history.” Johnson and Kwak are referring to the 50 years from the 1930s through the 1970s.

Ronald Reagan, of course, brought us back to the efficient-market hypothesis with its faith in laissez-faire — a faith embraced, to one degree or another, by all of Reagan’s successors as well. Who needs government oversight when markets correct themselves, they agreed, and so they stood by as regulations disappeared or were canceled. Even the Obama administration, seeking to revive regulation, has not easily shaken off the old faith in markets — and “13 Bankers” needles the president’s team on this point.

For example, the authors skewer Lawrence H. Summers, the director of the National Economic Council, and thus Obama’s chief economist. In 1998, while he was deputy secretary in the Clinton Treasury, he opposed the efforts of Brooksley Born, then running the Commodity Futures Trading Commission, to regulate derivatives. Her efforts “provoked furious opposition, not only from Wall Street but also from the economic heavyweights of the federal government,” Johnson and Kwak write.

Drawing on previously published accounts (this book’s great virtue is its skillful synthesis of what is already on the record), Johnson and Kwak describe a phone call from Summers to Born that gives the book its title. “I have 13 bankers in my office,” he declared, “and they say if you go forward with this you will cause the worst financial crisis since World War II.”

No wonder derivatives remained unregulated. And in the end, they played a huge role in producing what was in fact “the worst financial crisis since World War II.” Summers was dead wrong.

But if the case against him and others is so obvious, why did Johnson and Kwak, who run an economics blog called The Baseline Scenario, fail to speak up before the crisis erupted? Johnson, in particular, has emerged as a critic only in the past two years. If only he had separated himself sooner from the legions of mainstream economists who insisted that bankers and markets would self-correct.

Nonetheless, “13 Bankers” is persuasive penance — a well-documented appeal to embrace once again Thomas Jefferson’s skepticism of concentrated banking power. Or, as Johnson and Kwak conclude: “The financial crisis of 2007-2009 has made Jefferson a little less out of fashion.”

Louis Uchitelle writes on economics for The Times and other publications.

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Books »A version of this article appeared in print on April 25, 2010, on page 13 of the Sunday Book Review.